My 2017 Energy Predictions

I read an article this morning where one analyst predicted that we are in a 10-15 year bear market for oil. The analyst stated that the market is oversupplied by about a million barrels per day (it isn’t — see the charts in today’s article), that shale oil production will surge this year (it won’t), and that the OPEC agreement to cut production would fall apart (it won’t). His projection was that we will spend 2017 below $50 per barrel (bbl) and in 2018 prices will be back below $40/bbl.

I disagree with this assessment. I believe we will look back in a few years at 2016 as the year the energy sector recovery got underway in earnest. I believe 2017 continues the recovery. Today, I explain how I see the energy markets shaping up this year, in the context of my 2017 predictions.

1. Crude oil will flow through the Dakota Access Pipeline (DAPL) in 2017.

Donald Trump’s surprise win in the 2016 presidential election will result in big changes in U.S. energy policy. One immediate impact will be in the support at the federal level for oil and gas pipelines. The Obama Administration implicitly encouraged opposition to high profile projects like the Keystone XL Pipeline, and more recently the Dakota Access Pipeline (DAPL). Decisions on these projects came down on the side of pipeline protesters.

With Trump in office, DAPL will be completed and oil will flow. The only real uncertainty in my mind over this prediction is that Trump comes into office pretty disorganized, and President Obama has put a lot of obstacles in front of him. He will have a lot of competing priorities, and there will be legal challenges. Those will take some time to sort out. Nevertheless, I expect the pipeline to be completed and the oil to flow this year, much to the chagrin of pipeline protesters.

2. The price of WTI will average at least $15 per barrel higher than in 2016

I feel compelled to make an oil price prediction, but this year is much more difficult than a year ago, when I was confident that there would be a strong move upward from $30/bbl. This year I think oil prices will continue to move up, but a lot of optimistic expectations are already factored into the price.

According to data from the Energy Information Administration (EIA), the average closing price for West Texas Intermediate Crude (WTI) in 2016 was $43.31. During the year the price closed as low as $26.19 and as high as $54.01. The EIA’s most recent Short Term Energy Outlook projects Brent Crude prices to average $51.66 and WTI Crude prices to average $50.66 this year, but some are predicting a return to $40 or lower in 2017.

As I write this, WTI is trading at $50.81 and Brent is $53.62. This prediction will require the price of WTI to average at least $58.31 for the year, which is an average that is 15% above the current price, and also currently above the futures price of every contract trading in 2017. This prediction is essentially a bet that the OPEC production cuts will largely hold, which will minimize the risk of a strong downside move. However, there are headwinds to the upside. Even now the U.S. rig count is increasing, and while it is still only a third of the highs of 2014, it is up 60% since summer and will continue to rise alongside oil prices.

Crude oil inventories are still high, but the International Energy Agency’s most recent Oil Market Report showed that they were trending down even before the OPEC announcement to cut production:

Source: International Energy Agency

It is certainly true that a couple of years ago there were a couple million barrels per day (bpd) of oversupply, but falling U.S. shale oil production and another year that added >1 million bpd of demand had roughly balanced the market in the 2nd half of the year:

Source: International Energy Agency

As a result, I think this will be a less volatile year for oil, with dampers on the high as well as low side. We should reach $60, and I think OPEC is targeting at least that level. But it is hard to convincingly argue that the annual average will go that high (admittedly even $58.31 is a stretch for a yearly average) considering the current price, the fact that global crude inventories are still extremely high, and the expected increase in U.S. shale oil production.

This is a prediction that hinges on many factors, which makes it all the more difficult. If by the second quarter it is clear that global crude inventories are coming down rapidly, then I think we will see a $60 average for WTI for the year. However, if we see the OPEC agreement start to fall apart, we will likely retreat back to the $40s temporarily. So while some may not consider this an extremely aggressive prediction, it is a difficult forecast that could look silly in hindsight depending on how events play out.

3. The average Henry Hub spot price for natural gas will be above $3.50/MMBtu

In 2016 the average spot price of Henry Hub natural gas was $2.52 per million British thermal units (MMBtu). But by year-end the price was surging in response to depleting inventories. At present the forward price curve for natural gas in 2017 ranges from about $3.13 per MMBtu up to about $3.37, before falling back below $3 in early 2018. This seems too low given the strong demand growth coming online from new petrochemical projects, the utility sector, liquefied natural gas exports and growing pipeline exports to Mexico. Demand has been growing for years, but production growth has kept pace, keeping prices depressed. Natural gas production stalled in 2016 in response to low prices, and although I think it will bounce back this year I think this year we see demand get the upper hand.

The weather always has a strong influence on gas prices, but unless there is an extended bout of mild weather it will be hard to keep natural gas prices near current levels. I believe natural gas has more upside than oil in 2017, and that the average closing Henry Hub spot price will be above $3.50 for the year.

4. U.S. oil output will offset less than a quarter of the announced OPEC production cuts

From 2011 through 2015, U.S. crude oil production increased by 4.85 million bpd — an average increase each year of ~1.2 million bpd. OPEC’s 2014 decision to defend market share had a chilling impact on oil prices, with U.S. oil production entering a year-over-year decline in April 2015 that continued in 2016.

OPEC’s recent decision to cut production has many predicting that U.S. shale oil producers will simply ramp up drilling, replacing the 1.2 million bpd that OPEC members agreed to cut. Some have predicted that producers could offset the entire production cut in 2017, while others (like Citigroup) see the potential for a 500,000 bpd offset if oil prices climb to $60/bbl.

I believe these projections are quite optimistic for 2017. Shale production declined by ~600,000 bpd from 2015 to 2016, and while production was turning back up at the end of the year, I don’t believe it will ramp up rapidly, for several reasons. Shale oil production will likely increase, but it can’t turn on a dime. My prediction assumes that in 2017 U.S. crude oil production will grow by less than 300,000 bpd (a quarter of the announced OPEC cut) above the average daily crude oil production level in 2016 of some 8.8 million bpd.

5. The total return of the Alerian MLP Index will be at least 20% in 2017

Last year I predicted that the Energy Select Sector SPDR ETF would rise at least 15% in 2016 as the energy sector began to recover. The XLE rose 27% on the year amid a broad energy sector recovery.

I expect to see further gains this year in the XLE, but one group that lagged last year’s energy surge was the MLPs — the master limited partnerships that still predominate among the midstream operators. The Alerian MLP Index (AMZ) was up 9% for the year, while yielding about 7%. That wasn’t terrible, but it was well behind the rising energy tide.

I expect President Trump to be extremely good for MLPs and the entire midstream space. Over the past eight years the Obama Administration has created a tough climate for energy pipelines. The resulting negative sentiment is one of the factors weighing down midstream equities. I think we will see a great deal of top-down political support for the midstream sector over the next four years, and as a result I firmly believe MLPs will do very well in 2017. I expect the total return of the Alerian MLP Index — which consists of the price return of the AMZ and the distributions by its components — to reach at least 20% in 2017.

Conclusions

There you have my 2017 energy predictions. I believe the themes this year will be upward pressure on oil prices, U.S. shale oil producers picking up production a bit in response to the uptick in prices, increasing momentum for natural gas demand and a much friendlier federal approach to fossil fuel development. I will provide regular updates to these predictions as appropriate, but these are the final predictions I will grade myself on at the end of the year.

Finally, please note that these are my opinions and should not be considered as investment advice. Feel free to utilize my opinions as part of your due diligence process, but don’t rely on that exclusively. Predictions aren’t guarantees, so sometimes you may lose money. Not most of the time (historically), but just keep in mind that your investment decisions are your own.

Optimism is increasing and reaching all time highs for business, economic growth, and a bright future. We had a tamped down economic growth roughly for a decade that even so, did grow at a modest level. Some of that growth, artificially supported with national debt. So, there appears to be pent up demand and business opportunities waiting to be released. Expected economic growth will make the concerns of high national debt less of a concern. Same with the entitlement load. America’s younger generations have never been in a position to make good money and a high percentage seem to be unmotivated per the expected future tax load required to pay for it all. They have a comfortable life with minimal income and envision that path more comfortable. All of this when they were told, if attaining an ever more expensive college degree was all that it took. An education that continues to be more concerned with political indoctrination than improving citizens moral training and to increase the motivation for practical training to perform better within real world needs. Also, we know the infrastructure of the country will improve. The investments and construction at this level is expected to improve the countries base for continued economic growth. Infrastructure is expected to improve and not just a talking point to win acceptance of an political agenda. No bait and switch expected. People are starting to realize the country may be run by a CIC that has no agenda other than to make the country great again. So, basically what has worked in the past, we strayed so far from. I don’t think were being set up for political gain as some would believe. That may be a result, but not the motivation or action planned on. Trump seems to be hitting on all cylinders on this and not so easily swayed by the corrupt business as usual crowd running Washington. That’s the draining the swamp issue. All of this takes energy and that would be a priority of the administration to take away all hamstrings of production and the business of energy, therein. I do think we have reached the point of massively diminishing returns on the benefit of regulation. The job now is to make that industry more efficient and cost effective while maintaining 80%-90% of the benefit. Taking 2 regulations out for every additional regulation is a clever practical way of accomplishing this. The U.S. looks to be poised to be the economic engine that will pull the international economies from the brink of implosion.

I was reviewing quad btu energy use of country. First the world uses 543 quad. The U.S. consumes 98 (2015) quad or 18% of world total. For the U.S., petrol sits at 35 quad, natural gas 28, coal 16, nuclear 9 and renewable 10. So, if ever the country wanted to put a dent into petrol reliance, they should attack upon all fronts. These environmentalist waste so much time and money attempting to dis competition to their most endearing solution of wind and solar. Forget it. You environmentalist need to maximize every form of non carbon energy. Also, you need to focus on natural gas when using a NR carbon fuel. Quit, attacking nuclear, hydro, biomass, and biofuel. Quit focusing all your solutions to battery car.

Energy department report claims 2.6 quad could be harvested from our waste streams. It appears biomass could boost to 12-24 quad. So, that leaves an extreme need for nuclear, wind, solar, hydro, biofuel, and anything else. All of this will take a very long span of time and money. Petrol and coal are the hero as they are putting up an incredible quantity of international energy for the history of advanced civilizations. Good for the U.S. to develop these resources as the critical need will not soon dwindle. We can push hard for renewable energy as that is a gargantuan task, nonetheless we may improve prosperity with our technology and provide alternative solutions to the international market. Best get with the challenge as if we sit pacified with current supply of cheap energy we will pay the price. No need to act up with hamstring the efficiency of petrol or natural gas products as that is just committing harakiri. They need to work and work hard, but so should the alternatives.

Happy New Year, Robert, and all the best to you, your family and colleagues in 2017!

Enjoyed the follow-up on the ’16 predictions. I suspect you’ll get at least 3 out of 5 for the current year.

As a bit of an aside, I do not believe economic growth will return to that brisk, albeit temporary pace, of the 1980′s. Accumulated public debt and concomitant debt-service obligations (at home and abroad) will hamper sustained growth absent a marked improvement in capital formation, robust business recapitalization combined with steady increases in productivity and improving household incomes. A couple of percentage point increases in these categories will be insufficient to sustain significant ( > 3%) growth and further improvement in job creation. Is a recession looming? Not necessarily, but the prospects for the US economy have never been more closely tied to the well-being of our trading partners. On that note, we might be wise to stop beating our chest while threatening to rip up trade agreements and focus instead on keeping the trade/capital flows on an even keel. Alas, that certainly seems at odds with the temperament of the incoming president and his team.
We shall see.

Did you read the oil production article by John Mauldin is the chairman of Mauldin Economics? Technology is having an impact at the drill rig and the vehicle. All of it is good news for the U.S. economy, but those poor Arabs, Canadians, and Russians. They counted on the U.S. being a big consumer and to flip this to supplier, ouch. Much money to be made, but they can make it even with lower oil prices. My guess the winner of this oil business would be the supplier of equipment and technology for international sales. Bakerhughes? The rig count needn’t go up if the efficiency goes up instead, but they still need all the supplies. Maybe this would be a good time to increase tax burden of U.S. oil products consumption as economically speaking a good way to throttle some of the production and keep exports high. Also, may be a less painless source of much needed revenue. Michigan just put in a large road tax on fuel. Natural gas is best used domestically as the high cost of export reduces the value. We should pivot to utilize more domestic gas production.

I’m not swayed either way on the issue of price. I’ve poured over numerous academic papers on forecasting commodities (esp. oil) prices. One clear trend has emerged: all the experts expertly forecast the past.

What I mean by that is experts (e.g., economists, academics, traders, etc…) can overfit the historical data very well and tend to do a good job rationalizing the causality. However, I keep seeing over and over how they all get the future wrong. Instead of simplifying their premises, they instead add more variables and complexity to their models. This, of course, adds to fragility.

Undoubtedly, technology and depletion are in grudge match right now. Technology pressures costs down, while depletion pressures costs up. On one extreme, you have those who forecast an infinite supply of resources — to them, technology is the panacea. On the other end, you have Malthusians who believe that mankind is at or near the verge of peak resources.

As for me, I think it could go either way. Technology is improving rapidly and society has begun switching to renewables. This implies lower hydrocarbon prices in the future. On the other hand, we do live in a finite world in which the technological limitations are increasingly evident — implying higher prices in the future.

The question is whether mankind is improving extraction technologies and switching to alternatives quickly enough to avoid the Malthusian ending. The answer to that depends really on the geology. How much of the hydrocarbon rich soup is really left? To that, I must admit that the events which took place over geological time scales to result in this soup is beyond my small-minded comprehension.

It looks so. Oil wars and technology will keep prices flat. Very interesting dynamics going on with oil producers. OPEC golden years of exploiting markets gone. U.S. shale is there to undermine their efforts and advantage themselves. Everyone wants to sell their reserves as it’s becoming evident that technology is having an impact. As you know I follow the biofuel technology and can only say lots of eagerness on that side. Hydrogen solution is just starting to bloom. Solar and wind are becoming smarter and less expensive. Nuclear SMRs are the real deal. Hydrogen production solves a lot of energy supply and balancing problems. The grid will go to hybrid and avoid the costly high voltage supply lines. The hydrogen pipeline replaces that. Solar will amp up as cost continues to go south. Vehicles will become amazingly efficient in both energy/mile and utilization. Same for households. DC voltage may come back as the power of choice for homesteads. After that change most households will find it easy and cheap to produce their own power. No grid required. Renewable fuel will continue to increase production, including the biogas.